Why tax reform is doomed - Note for a lecture, "E Pluribus Unum? What Keeps the United States United"

Almost everyone agrees that America’s income tax is too complex. Considering this, you might expect that simplifying the income tax would be a slam dunk. Sure enough, the various presidential candidates have proposed sweeping overhauls. But any agreement is mostly rhetorical. The odds that the next president — whoever it is — will engineer genuine tax simplification are negligible. In the wake of another Tax Day, it’s worth pondering why.Make no mistake: I think we’d be better off with a simpler system. By this, I mean a system with a broader tax base and lower rates. I’d eliminate most tax preferences and cut the top personal rate (now 43.4 percent) to 30 percent. There would be no preferential rate on dividends, interest and capital gains (profits on the sale of stocks, bonds and other assets) — income enjoyed mostly by the upper middle class and the wealthy. They’d pay as much or more in taxes as today.

Here are some tax preferences (a.k.a. “loopholes” or subsidies) I’d repeal along with government estimatesof how much tax revenues would rise in 2016:

● The exclusion from taxable income of employer-paid health insurance ($211 billion).

● The deductibility of state and local taxes ($84 billion).

● The deductibility of mortgage interest ($62 billion).

● The deduction for charitable contributions ($54 billion).

● The partial tax-free status of Social Security ($40 billion).

In total, the income tax would raise as much revenue as it does now, but top rates would be lower and preferences fewer. If more money were needed to close budget deficits (as is likely), I’d slowly introduce a carbon tax. Still, I would keep two big tax preferences, because they advance crucial national goals.

The first is the earned-income tax credit (EITC), which is a federal wage subsidy for low-income workers. It’s a better way than the minimum wage of rewarding people for connecting to the labor market. The second exception would be tax-favored retirement accounts: IRAs and 401(k)s. By the time people reach their 40s or 50s, most realize they should have been saving for retirement. Tax-favored accounts give a nudge to people in their 20s and 30s.

The resulting tax system would be a vast improvement over today’s. It would be simpler, fairer and more efficient. It won’t happen.

Glance at my list of targeted tax preferences, and you can understand why. If proposed, comprehensive tax simplification would trigger a firestorm of complaints. Workers would have to pay taxes on employer-provided health insurance; they’d scream. Home builders and homeowners would denounce the loss of the mortgage-interest-rate deduction. Real estate values would be affected. Churches and colleges would protest ending the charitable deduction. Retirees would object to making all Social Security income taxable.

The truth is that these tax preferences have woven themselves into the nation’s social and economic fabric. Removing them would be disruptive and unpopular. Even if Congress accepted that, there would probably be complex “transition” rules. For a while, the tax code might become more complicated. But of course, Congress wouldn’t end most tax preferences, because the benefits of doing so are diffuse and obscure.

I believe that lower marginal tax rates should promote faster economic growth by encouraging greater work effort and investment. But as White House economist Jason Furman has noted, the effect is hard to measure and could be quite small — not large enough, he argues, to justify the dislocations of purging the tax code of most preferences. My view is that simplification is worth doing even if the effect on economic growth is zero. It would get the White House and Congress out of the business of using the tax code to reward and punish various behaviors and causes. People and firms would act based more on underlying motives, not tax benefits.

The trouble with my view is that the White House and Congress want to use the tax code to reward and punish. This enhances their power; relinquishing it reduces their power. We know this from history. The Tax Reform Act of 1986 followed the dictum of lowering rates by broadening the tax base. It was a commendable achievement, a rare example of bipartisanship. President Resagan supported it, as did many Democratic and Republican congressional leaders. It might have, if followed by similar laws, transformed the tax code.

But it wasn’t. Instead, President Clinton sabotaged it by raising the top rate and peddling new tax breaks. This spirit is alive and well among Democrats. By contrast, Republicans are hypocrites. They’d rather attack the Internal Revenue Service than undertake the hard political work of making the IRS’s job easier.

Accountants’ and tax lawyers’ jobs are safe. Our hideously complex tax code has staying power. It survives not because it serves the nation’s best interest, but because it placates so many groups that make up the nation.

About Me

A Princeton PhD, was a US diplomat for over 20 years, mostly in Eastern Europe, and was promoted to the Senior Foreign Service in 1997. For the Open World Leadership Center, he speaks with
its delegates from Europe/Eurasia on the topic, "E Pluribus Unum? What Keeps the United States United" (http://johnbrownnotesandessays.blogspot.com/2017/03/notes-and-references-for-discussion-e.html). Affiliated with Georgetown University (http://explore.georgetown.edu/people/jhb7/) for over ten years, he still shares ideas with students about public diplomacy.
The papers of his deceased father -- poet and diplomat John L. Brown -- are stored at Georgetown University Special Collections at the Lauinger Library. They are manuscript materials valuable to scholars interested in post-WWII U.S.-European cultural relations.
This blog is dedicated to him, Dr. John L. Brown, a remarkable linguist/humanist who wrote in the Foreign Service Journal (1964) -- years before "soft power" was ever coined -- that "The CAO [Cultural Affairs Officer] soon comes to realize that his job is really a form of love-making and that making love is never really successful unless both partners are participating."